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Multimarket Trading and Market Liquidity

Bhagwan Chowdhry¹; Vikram K. Nanda^2,3

¹ University of California, Los Angeles · ² University of Southern California · ³ California Southern University

When a security trades at multiple locations simultaneously, an informed trader has several avenues in which to exploit his private information. The greater the proportion of liquidity trading by “large” traders who can split their trades across markets, the larger is the correlation between volume in different markets and the smaller is the informativeness of prices. We show that one of the markets emerges as the dominant location for trading in that security. When informed traders can use their information for more than one trading period, the timely release of price information by market makers at one location adversely affects the profits informed traders expect to make subsequently at other locations. Market makers, competing to offer the lowest cost of trading at their location, consequently deter informed trading by voluntarily making the price information public and by “cracking down” on insider trading.

DOI

10.1093/rfs/4.3.483

Volume

4 (3)

Pages

483-511

Language

en

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